Cobb Company currently produces and sells 9,000 units annually of a product that has a variable cost of $20 per unit and annual fixed costs of $195,000. The company currently earns a $228,000 annual profit. Assume that Cobb has the opportunity to invest in new labor-saving production equipment that will enable the company to reduce variable costs to $16 per unit. The investment would cause fixed costs to increase by $25,000 because of additional depreciation cost.

Use the equation method to determine the sales price per unit under existing conditions (current equipment is used).

Prepare a contribution margin income statement, assuming that Cobb invests in the new production equipment.

1. Seling price is $67 per unit

2.

Sales $603,000

Variable cost (144,000)

Contribution margin $459,000

Fixed cost 220,000

Operating income $239,000

Explanation:

1. Using the equation method of determining the unit sales price,

First, compute the contribution margin. Find the sum of the total fixed cost and the annual profit.

Fixed cost + annual profit = contribution margin

$195,000 + $228,000 = $423,000

Second, compute the sales in dollars. Add contribution margin and variable costs to get the sales in dollars.

Sales = variable cost + contribution margin

Sales = $180,000 (9,000 x $20) + $423,000 (as computed above)

Sales = $603,000

Finally, to get the sales price per unit, we have to divide the sales in dollars as computed above from the number of units sold.

$603,000 / 9,000 units = $67 per unit

2. If the company will invest on the new production equipment a decrease in variable cost to $144,000 and an increase of fixed cost to $220,000 will affect the company's operating income.

Sales ($67 x 9,000 units) $603,000

Less: variable cost ($16 x 9,000) 144,000

Contribution margin $459,000

Less: Fixed cost ($195,000 + 25,000) 220,000

Operating income $239,000